Energy stocks have lost nearly two-thirds of their value in the last six years. Are they a buying opportunity? Or a lost cause?
In the past few weeks, I’ve received a number of questions from subscribers about energy stocks. Some ask about what to do with their down-and-out holdings, others ask about whether it is time to bottom-fish. These are exactly the right kinds of questions to be thinking about.
By far the worst-performing sector in recent years has been the energy sector. From its peak in mid-year 2014 when oil prices reached over $100/barrel to its current state of complete disarray, the S&P 500 Energy Sector index has collapsed 63%. For comparison, the broad S&P 500 index has gained 65% and even the often-maligned Materials Sector index has risen by 25%.
Obviously, it has been very difficult (nearly impossible) to make any money holding energy stocks. The strongest performer in the S&P Energy sector, Cabot Oil & Gas (COG), saw its share price increase by a microscopic 3% in the past five years. Nearly all of the others have produced large losses. Returns have been so weak that the S&P 500 Index now includes only 21 energy stocks with market caps over $5 billion.
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Some Energy Stocks to Watch
That said, I currently have Marathon Petroleum (MPC) and Total (TOT) listed as “Hold” recommended stocks in my Cabot Undervalued Stocks Advisor portfolio. These two particular energy stocks have somewhat unique traits that provide some appeal.
I’m also tempted by beaten-down but high-quality service companies like Schlumberger (SLB) and Helmerich & Payne (HP), but the cash flow prospects of these kinds of stocks in a $45 oil price environment seem too weak to support both debt service and capital spending requirements. Exploration and production companies typically carry unserviceably high debt yet must spend to maintain production, so they look more like call options than actual shares. Many are expiring worthless as they slide into bankruptcy.
Even most of the global majors need to further rein in their operations to sustainably balance their expenses, debt service, capital spending and dividends.
What would lead me to start buying energy stocks more aggressively? I’m wiser (cautious?) about venturing in after taking losses on several energy stock holdings, yet at the same time eyeing potentially vast upside in a recovery. The range of outcomes is exceptionally wide (‑100% to +500%) for many energy stocks, so my approach is to find ideas where the downside is limited enough that it makes the potential upside worth the risk. This is a work in progress.
While we probably have reached “peak oil” at 100 million barrels/day, global demand will remain sturdy and needs to be filled. Permanent impairment of many U.S. oilfields along with the broken E&P business model, and possible civil unrest in 3-5 years as currently-stable Middle East regimes lose their ability to subsidize their populations, could weaken supplies. Eventually, demand for energy services will return while many low-quality providers will have vanished.
It is very unclear yet when and at what price oil and natural gas will begin to reflect this scenario. Yet, while the near-term looks grim, these scenarios paint an optimistic longer-term picture for energy stocks.
Editor’s Note: This post was excerpted from the latest issue of Cabot Undervalued Stocks Advisor. To read more, click here.
Bruce has more than 25 years of value investing experience, managing institutional portfolios, mutual funds, and private client accounts. He has led two successful investment platform turnarounds, co-founded an investment management firm, and was principal of a $3 billion (AUM) employee-owned investment management company. Now he is helping his Cabot Undervalued Stocks Advisor readers find those undervalued stocks that let you buy low and sell high!Learn More >>